Foreign direct investment a global perspective

Chapter 1 International Players: From Western Chapter 2 International Business Strategy: From Chapter 3 The Western Perspective on FDI: From Market Chapter 4 The Global Perspective on FD

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Seoul National University, South Korea

Hwy-Chang Moon

INVESTMENT

A G l o b a l P e r s p e c t i v e

Library of Congress Cataloging-in-Publication Data

Mun, Hwi-ch’ang.

Foreign direct investment : a global perspective / Hwy-Chang Moon, Seoul National University,

South Korea.

pages cm

Includes bibliographical references and index.

ISBN 978-9814583602 (hardcover) ISBN 981458360X (hardcover)

1 Investments, Foreign 2 International business enterprises I Title

HG4538.F6183 2015

332.67'3 dc23

British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from the British Library.

Copyright © 2016 by World Scientific Publishing Co Pte Ltd

All rights reserved This book, or parts thereof, may not be reproduced in any form or by any means,

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The conventional theory of foreign direct investment (FDI) is to view the

motivation of FDI as “exploiting” the ownership or monopolistic

advan-tages of multinational corporations (MNCs) in an industry which has a

high degree of market failure In this exploitative world of MNC

opera-tions, countries may be adversely affected However, in today’s more

com-plicated and competitive environment of business, MNCs are more willing

to co-create values through “sharing and learning” with home and host

countries by constructing a global ecosystem, rather than just to exploit

their advantages In this cooperative world, both MNCs and countries will

benefit I have confirmed this new compelling perspective through my

related consulting projects and extensive studies on this subject It is now

imperative to broaden our scope of analysis on the operation of MNCs

and their impact on countries

This book is different from existing studies particularly as it relates to

some important points First, most of the existing studies focus on FDI

from developed country MNCs, i.e., the Western perspective, but this book

deals with both developing and developed country MNCs, i.e., the global

perspective Second, this book focuses more on cooperating than

compet-ing nature of multinational activities between firms and countries, thereby

enhancing synergies between them and creating new business

opportuni-ties Third, this book extends the conventional perspectives on other

important topics, including foreign entry modes, clusters, and creating

shared value on both the firm and country level In addition, this book not

only add values to academia, but also gives useful strategic implications for

both business managers and policy makers

For the publication of this book, I would like to give special thanks to

Sohyun Yim, who has helped me from the beginning to the end of this

project Without her dedication, this book could not have been completed

within a reasonable timeframe Thanks also go to Jimmyn Parc, Sylvain

Rémy, Wenyan Yin, and Yeon Woo Lee, who have contributed to some

parts of this book in a close consultation with me In addition, I would like

to thank the editorial staff members of World Scientific Publishing Co., for

their valuable help in publishing this book

Hwy-Chang Moo nSeoul National University

Chapter 1 International Players: From Western

Chapter 2 International Business Strategy: From

Chapter 3 The Western Perspective on FDI: From Market

Chapter 4 The Global Perspective on FDI: From OLI

Chapter 5 FDI Impacts on Country: From Negative

Chapter 6 FDI and Cluster: From Local to Global Link 97

Chapter 7 Assessing the Investment Attractiveness: From

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Trade balance no longer represents the economic performance of a nation;

rather it is at best a distorted and at worst a wrong picture of national

competitiveness It is because multinational corporations (MNCs) have

become increasingly mobile and input resources are mobilized

every-where Firms build competitive advantages by investing their activities and

finding new resources on a global basis, and this can enhance the national

competitiveness as well Such activities of MNCs are called foreign direct

investment (FDI)

FDI theories were mainly developed from the traditional economic

perspectives on market failures by tackling the underlying assumption of

neo-classical trade theories, i.e., the perfect market system and factor

immobility across national borders Hymer, the grandfather of FDI

stud-ies, averred that MNCs grow in order to exploit their monopolistic assets

in foreign locations, thus need to be regulated further deteriorate

structural market failure On the other hand, Williamson regarded that

transaction-cost-based market failure is endemic, so that MNCs need to

be encouraged to make market transactions more efficient

Dunning, who established the backbone of FDI theories, has

incorpo-rated both economic perspectives on market failures and business

perspec-tives of value creation Dunning’s theory was initially developed from

Hymer’s monopolistic assets to explain why firms invest abroad (later named

as ownership advantage), then he identified location-specific advantage to

explain where MNCs choose to invest Although Dunning explained that

the main purpose of FDI is to exploit ownership advantages in foreign

locations, he acknowledged the importance of internalizing the market for

MNCs to grow and enhance their current ownership advantages Thus he

added the third ladder and called this the internalization advantage to

explain how firms engage in foreign operations The three advantages

together formed the tripods of the ownership-location-internalization

(OLI) paradigm and became very useful to explain why MNCs from

devel-oped countries invest in developing countries (downward investments)

Despite Dunning’s contribution to FDI studies, the OLI paradigm is

based on the firms from developed countries that already possess

owner-ship advantages From the late 20th century, however, firms from

develop-ing countries started investdevelop-ing in developed countries (upward investments),

without any significant ownership advantages compared to other MNCs

from developed countries In the world of Dunning’s conventional OLI

paradigm, these upward investments were rather regarded as an

excep-tional phenomenon

To explain this unconventional phenomenon, Moon and Roehl

intro-duced the imbalance theory based on Penrose’s perception that the

imbal-ances in resource portfolio make firm grow They applied her perception

to international business and claimed that it is not only the advantage of

the firm but the imbalances of the firm resources that motivate firms to

invest abroad to address the current imbalances Both affluence and

defi-ciency of resources will motivate firms to go abroad, but the defidefi-ciency will

stimulate firms more for their survival and for overcoming critical

disad-vantage of the firm The imbalance theory does not only overcome

limita-tions of OLI paradigm but also gives a significant implication that firms

need to constantly balance out any of the imbalances that reside in their

value chain

The imbalance theory can also further be applied to host country’s

strategic policies to attract the most competitive MNCs and maximize their

spillover effects The host country needs to provide a business environment

in attracting MNCs to utilize their advantages while also complementing

their disadvantages The most effective way of achieving these two goals is

to build a cluster to exchange resources and knowledge The cluster usually

is referred to as firm networks that are situated spatially close to each other,

but it can be expanded to the networks of clusters across regional and

national boundaries The global linkage between Silicon Valley in the US

and Bangalore in India is a good example

The competitiveness of clusters can be enhanced from the four

endog-enous determinants of Porter’s diamond model (factor conditions, demand

conditions, related and supporting industries, and firm strategy, structure

& rivalry), and two exogenous determinants (government and chance)

These interactive determinants together form a self-reinforcing

mecha-nism of creating sources of locational competitive advantage Although the

diamond model was originally introduced to analyze the competitiveness

of national industries, this model can be utilized and extended as a tool for

analyzing locational attractiveness for global managers This book

intro-duces new extended models that were utilized to assess locational

attrac-tiveness The case studies of Korea and Azerbaijan were conducted to give

strategic implications for both global managers to choose the most

appro-priate investment locations and for policy makers to develop attractive

business environments

Not only choosing the appropriate location is important but how to

enter the location is critical Firms can either externalize or internalize

foreign markets Externalization is to engage in arm’s length transactions

through trade or licensing, while internalization is to engage in a certain level

of equity or control over a foreign firm through forming strategic alliances

or joint ventures, or setting up a wholly owned subsidiary Inter nalization

theory or the entry mode choice was initially analyzed from the market

failure perspective, yet by adding locational factors and complementarity,

we can explain different internalization modes as well as different

exter-nalization modes (e.g., inter-firm trade, intra-firm trade, and licensing)

Although scholars and practitioners are finding more positive

ration-ale for the MNC activities, the FDI impacts on both host and home

coun-tries have been controversial There may be more positive impacts of FDI

on both the host and home countries that can outweigh possible negative

impacts However, negative impacts cannot be ignored With growing

pub-lic awareness as well as institutional pressures on the environmental and

social issues, firms need to seek ways not only to mitigate negative impacts

but also to find new business opportunities by solving critical

disadvan-tages at the home and host countries This is the so-called “creating shared

values (CSV)” between MNCs and both the home and host countries

Firms finding social opportunities will foster cooperation towards creating

new sources of competitiveness together with the home and host

coun-tries, so that firms can reduce tensions with the national governments and

continue to generate new sources of competitive advantages

All of the chapters of this book highlight the changing perspectives

regarding FDI such as from western multinationals to global firms, from

traditional theory to new theory, from local to global link, and from

responsibility to opportunity The readers of this book can thus

under-stand the past, present, and future of the strategic issues regarding FDI and

global value chain of business

There are no firms or industries that are purely domestic Most of the goods

that are accessible in the marketplace are now “made in world.” Yet we have

a very limited view on how global firms and industries have emerged For

a better understanding of the strategies in the business world, different

kinds of international firms are introduced Their strategies may be regional

or global, standardized or diversified (localized) depending on physical and

psychic distances Both physical and psychic distances, however, should not

be taken as a cost of foreignness but a source of new opportunities In this

chapter, we will see how international firms have evolved to take advantage

of these new opportunities

1.1 National Interest vs National Allegiance

Over the several decades, firms have learned that they can benefit largely

from foreign production They can dramatically lower their production

costs, increase their foreign demands for their products, and explore new

markets (Farrell, 2004) Their influence stretches far beyond national

boundaries, and the international competition has changed

Let’s take a look at the case of aircraft production as shown in Figure 1.1.1

There are only two aircraft producers in the world, the Airbus from the EU

1

Doors and windows, escape slides, engine nacelles, and auxiliary power units are made in

the US, whereas flight deck seats (UK), passenger doors (France), and cargo doors

and Boeing from the US Although the market looks as if the competition

exists between the EU and the US, the actual competition takes place in a

global arena Parts and components of the Boeing aircrafts are produced

from around the world The aircraft buyers (airline and transportation

companies) and end customers (travelers) are spread all around the world,

so it is almost impossible to determine the nationality of the product or

the company Products and services are “made in world” and serve the

worldwide market in which firm competitiveness arises based on how

these two firms can manage their made-in-world products

Then how can we understand the changing nature of business

compe-tition? How are businesses taking place in the global economy? Let us

assume that there are two firms Firm A has directors and shareholders

from America but operates in a foreign country, South Korea On the other

hand, Firm B has directors and shareholders from Korea and its operations

(Sweden) are made in Europe For stabilizers, vertical stabilizer is made in the US,

hori-zontal stabilizer is made in Italy Raked wing tips are made in Korea Japan also takes a

large part in aircraft production Lavatories, forward fuselage, center wing box, pre-preg

composites as well as tires and wing box are made in Japan.

Figure 1.1 Boeing Aircraft: Made in World

Source : Meng and Miroudot (2011).

are mostly based in America and its R&D center is situated in Silicon

Valley Now, which of the two companies is American or Korean?

Firm A is owned by Americans (American shareholders) but it has less

relevance to American economy and competitiveness It hires few Americans

and creates values outside of America On the other hand, firm B is owned

by Koreans but is contributing more to the American economy and

employ-ment Its operations and sales are created in America Therefore, despite

the nationality of ownership, the company that adds more values to the

American economy is firm B

Some may argue that ownership and control can determine the

nation-ality of the firm For example, firm A will try to maximize benefits for

American investors Also, American managers, although they may operate

in foreign companies, will act in the best interest of America Yet, would

American managers put national interest before the firm’s interest? The

marketplace does not spare room for national allegiance when it comes to

a matter of survival in global competition The reality is that global

manag-ers make decisions of the location that will provide the most benefits to the

company, even if the decision benefits the foreign country more than it

does for America (Reich, 1990)

Firms behave on behalf of their own interests, not by national

alle-giance, unless the company is closely tied to their nation’s economic

devel-opment, either through direct public ownership or through finan cial

intermediaries (Reich, 1990) They may want to contribute to national

devel-opment but there may incur large inefficiencies Furthermore, the

govern-ment would not be capable of such detailed oversight of the firms In the

end, firms have to seek competitive strategies to pursue a lower cost or a

higher value creation to sustain their competitiveness, which means to

look for business opportunities both inside and outside the national

boundaries that serve their interests better

What about the host countries? The government policies, when

devis-ing strategies to benefit the national interest, must gear towards fosterdevis-ing a

favorable business environment that can attract global firms to bring in

foreign capital, technology, entrepreneurship as well as the technical

know-how (Reich, 1991) The nationality of the firm which brings in these

valu-able resources to the country does not matter as long as it contributes to

the national economy Thus, developing national competitiveness lies in

developing national policies that reward global corporation and foster a

business-friendly environment for global companies, regardless of their

nationality

Some may argue that the market equates the value and attitude towards

the product with the economic level or perceived value of the

country-of-origin Yet, as the market becomes more competitive, national allegiance

decreases in the market place The market has become much more

infor-med about the product and consumers choose and buy based on their

opportunistic behavior They try to maximize their own values rather than

stick to the national allegiance Thus, firm operations are not limited to

the national or regional boundaries and they need to seek resources and

capabilities that can best serve the market by providing cost-effective or

differentiated values in the global arena

1.2 Global Diversification of FDI

In the past, firms were engaged in foreign production, but their foreign

operations remained as subsidiaries to the headquarters that were based in

the country of the parent company (Reich, 1990) In recent times,

cross-border ownership has boomed, and their headquarters are not necessarily

based in their country of origin There are multiple businesses which are

spread across international strategic regions The high value-added

activi-ties, including R&D centers, are also situated where the knowledge is

highly concentrated and their production sites are relocated in places that

are most cost-effective and strategically important

The MNCs we see nowadays have their origins from the firms born

out of the second industrial revolution in the late 19th century (Guillen

and Garcia-Canal, 2009) In earlier years, firms were taking global

strate-gies to exploit natural resources for export or to supply foreign markets

with similar products to those produced at home (Dunning, 2001b) The

amount of investment was limited and the targeted industries or regions

were peripheral

The expansion of Western firms started from the end of the 1950s when

trade and investment barriers gradually fell around the world (Chandler,

1990) The multinationals from the US and the European countries started

to increase, mainly to serve the Western markets Their investments started

to diversify into the less developed countries, seeking cost reductions,

mainly in ex-colony countries, however, they remained unilateral No

investment flows were seen from these countries into the US and the EU

This is why FDI studies were mainly conducted on the Western firms and

focused on unilateral exploitation of firm resources and advantages

The first non-Western players were the Japanese firms that posed new

threats to the Western firms The Japanese firms did not only invest in the

Western market for knowledge sourcing and market access, but also in

Southeast Asian markets for a lower production cost Their investment

increased with their successful penetration into the Western markets but

was also stimulated by trade barriers set upon Japanese products Because

the inflow of Japanese products was increasing in the Western market,

the host governments imposed various trade barriers; mainly the

anti-dumping duties that made the Japanese firms use circumventing strategies

to maintain their sales in the Western market

After the 1990s, FDI volume started increasing from the newly

industri-alizing economies such as Spain, Portugal, South Korea, and Taiwan as well

as from oil rich countries such as United Arab Emirates, Nigeria, and

Venezuela In later stages, emerging large countries such as China, Brazil,

Mexico, India, and Turkey, and Southeast Asian countries such as Indonesia

and Thailand also started large amounts of outward FDI (Guillen and

Garcia-Canal, 2009) Thus, the global investment is not limited from the

traditional triad regions: the US, the EU and Japan but takes place around

the world Firm productions are distributed across national borders and

form a complex web of FDI The targeted location of FDI has also diversified

as the internationalization is becoming real

1.3 Globalization vs Regionalization

In terms of economic and cultural dependence, globalization is an

inevi-table phenomenon Yet, the degree of globalization is a different story

Indeed, some scholars such as Rugman and Verbeke (2004; 2008) argued

that globalization is skewed.2 Global business activities are dispersed and

2

Rugman and Verbeke (2008) also tested the multinational firms in service industries and

showed similar results to the earlier research conducted in 2004.

operated in the areas that are regionally or culturally close Their study is

not much different from what Kenichi Ohmae insisted in his book called

Triad Powers in 1985, explaining the “global impasse” of the triad regions

The triads are: the US, the EU, and Japan, where Ohmae observed that

these three regions are the main pillars of the global economy

Rugman and Verbeke (2004) examined the world’s largest MNCs

(Fortune 500) and where their sales are largely created They showed that

during the 1980s, firms created sales in one or two of the three regions of the

EU, the US, and Japan Among the Fortune 500, 135 firms operated in their

home region, with no sales elsewhere Twenty five firms had sales in two of

the three regions and only nine were global, in all three regions, including

Coca-Cola (ranked as 129th) and McDonald’s (ranked as 350th) The rest of

the firms were ambiguous due to lack of data

Such uneven distribution of MNCs’ sales across the globe shows that

there are limitations in transferring firm-specific resources while being

advan tageous for some regions Firms lack the capability to internalize the

foreign market and deal with local policies because they become less

com-petent in markets where the structures and policies are unfamiliar

After Rugman and Verbeke published their paper in 2004, Dunning,

Fujita, and Yakova (2007), while appreciating the micro-analysis,

exam-ined the macro perspective on regionalization and globalization Dunning,

Fujita, and Yakova (2007) improved and adopted new research methods;

using three indexes, namely, transnationality index (TI), globalization

index (GI) and the revealed investment comparative advantage (RICA).3

The classification of the regions used by Dunning, Fujita, and Yakova

(2007) was also revised from the Triad to six clusters of countries based on

geographical distances, country size (GDP), and psychic distances as well

3 The first index is the TI which is used to assess the degree of a country’s outward or inward

FDI The TI uses the percentage of foreign assets, sales, and employment accounted by the

foreign affiliates The second index is the GI, which attempts to assess the extent to which

the geographical spread of inward and outward FDI is concentrated or dispersed The third

index is the RICA or investment intensity index This is to measure the extent to which,

relative to its share of the world direct investment stock, a country’s outward investment

in a number of culturally different geographical regions is above or below the average.

as institutional differences.4 The categories are: Anglo cluster, Germanic/

Nordic cluster, Latin American cluster, Latin European cluster, Far Eastern

cluster, and “Other or Mixed” cluster, which includes all other countries.5

Yet, despite the differences and improved methodologies, the results

were similar in that firm investments were not well diversified

Geographically speaking, some regions have comparative/absolute

advan-tages in certain aspects, such as knowledge intensity, technology

concen-tration, and so on, whereas many firms also agglomerate in certain regions

to protect or enhance their technological, organizational, and managerial

competencies

Despite similar results regarding firms’ tendency on regionalization,

there are major differences between Rugman and Vebeke (2004; 2008) and

Dunning, Fujita, and Yakova (2007) works Rugman and Verbeke (2004;

2008) looked into “the locus of destination” that is the geographic

distribu-tion of downstream activities, where Dunning, Fujita and Yakova (2007)

included both the downstream and upstream activities of the firm Then

how can we systematically understand global investment pattern? What do

we mean by a global firm or global strategy? In order to address these

questions, it is important to understand the basics of firm operations and

different types of global firms

1.4 Different Types of Global Strategy

and Global Firms

Firms have been engaged in international activities in one way or another

Whether they are geographically concentrated or dispersed is a matter of

how firms design their international production and target markets

4 This was used by other scholars such as Ronen and Shenkar (1985).

5 The six regional clusters are as follows (1) Anglo: Australia, Canada, Ireland, New Zealand,

South Africa, US, UK (2) Latin European: Belgium, France, Italy, Portugal, Spain (3) Nordic

and Germanic: Austria, Denmark, Finland, Germany, Netherlands, Norway, Sweden,

Switzerland (4) Latin American: Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela

(5) Far Eastern: China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, Philippines,

Singapore, Taiwan, Thailand and (6) Other (all the rest).

To analyze why firms show different paths of internationalization, let’s

look into the generic value chain of firms (see Figure 1.2)

Porter’s (1985) generic value chain portrays the streams of many

dis-crete activities of firm operation Firms design, produce, and provide

various services such as marketing, delivery, and after sales support Each

activity is called as the value activity, which can be categorized into

primary and support activities Primary activities are those involved in the

physical creation of the product, its sales, and its transfer to the buyer as

well as after-sales support Support activities are the ones that assist the

primary activities by providing procurement, technology, human resources,

and firm infrastructure

Among the primary activities of the firm, inbound logistics,

opera-tions, and outbound logistics are associated with “inputs” management

and they are referred to as the “upstream activities” of the firm Marketing

and sales as well as service, which deal more directly with end buyers, are

referred to as the “downstream activities” of a firm Porter (1985) said that

the competitive advantage of a firm derives from how a firm can manage its

value chain activities in a better way

The activities may vary among firms Firms specialize in one of the

activities of the value chain, thus each of the value activities can be

sub-cat-egorized For example, a firm’s marketing and sales activity can be divided

into marketing management, advertising, sales force administration and

oper ations, and promotion (see Figure 1.3)

These specialized firms also outsource certain value activities or

coop-Figure 1.2 Porter’s (1985) Value Chain

For example, suppliers, final goods providers, and marketing and sales

firms are all independent but work together to complete an industry value

chain Firms in charge of resource development, raw materials, and

manu-facturing are the upstream firms of the industry value chain, whereas firms

Figure 1.3 Sub-categorization of Each Value Activity

Sources : Porter (1985), and Moon (2010).

Figure 1.4 Industry Value Chain

Source : Moon (2010).

Cooperation among firms goes beyond the national boundaries

Regardless of firm nationality, firms seek competitive partners to make

their industry value chain competitive This is why there cannot be any

industry that is purely domestic and any part of the value chain activities

can be performed in foreign locations

Then, which firms are global firms? We use various terminologies for

international firms such as multi-domestic, multinational, global, or

trans-national firms At one extreme, there is a multi-domestic firm that tailors

firm strategies and products to each local need Each foreign subsidiary

shows distinctive features of the locations and markets On the other

extreme, there is a global firm that implements parent firm strategies and

utilizes knowledge retained at the headquarters to provide similar goods

globally With standardized firm strategies and products, firms exploit

economies of scale A transnational firm does both of what multi-domestic

and global firms do The transnational firm has differentiated contribution

by national units to integrate worldwide operations The shared knowledge

is developed jointly among its foreign subunits MNCs are used in various

ways yet more specifically they are the half-way type of transnational firms

They are also referred to as multi-focal firms that exploit local

opportuni-ties, while retaining some of the common capabilities such as technology

and skills In reality, however, it is very ambiguous to categorize firms into

different types because their international activities have evolved and

per-formed in diverse ways Thus, the termi nologies to indicate international

firms have been used inter-changeably

Scholars have tried to explain international firm activities from

vari-ous perspectives One aspect to distinguish international firms is to see

how firms are integrated and coordinated across different regions and how

responsive they are to regional differences Prahalad and Doz (1987)

explai-ned that while firms need to take advantage of global efficiency and exploit

market imperfections that are derived from multi-country differences;

they need to be responsive to the demands imposed by the competitive

government or market forces in each location Thus, the framework is based

on two imperatives: Pressures for global integration and pressures for local

responsiveness This was modeled and named as the

integration-respon-siveness (I-R) framework

Global integration refers to the force that pressures firms to make

stra-tegic choices as a collective organization so that the activities are integrated

across national boundaries Local responsiveness is the force that necessitates

firms to be sensitive to local pressures and respond predominantly to each

local market and industry settings These two pressures force firms to make

strategic choices depending on their activities and industry characteristics

Thus, if we were to situate different types of international firms in the I-R

model, they would look as shown in Figure 1.5

Global firms are situated in the upper left where integration of the

activities is high and responsiveness is low In the lower right side of the

matrix, there are multi-domestic firms where responsiveness is high and

integration of activities is low These are the two extremes of international

strategies Transnational firms are situated in the upper right quadrant which

takes specialized and interdependent activities within the range of integrated

and standardized sets of strategies This is to achieve global efficiency and

exploit the firm-specific advantages on a worldwide basis while responding

to national differences (Bartlett and Ghoshal, 1999) Yet, firms make selective

decisions to integrate or communicate their activities differently and this is

why the multinational firm is situated in the middle (See Figure 1.5)

Despite the usefulness of the I-R framework, there are limitations

Because coordination is correlated to the integration of firms, Prahalad and

Doz (1987) did not distinguish coordination from integration However,

Figure 1.5 I-R Framework and Types of International Firms

Note: This figure was adopted and modified from Prahalad and Doz (1987), and Moon (2010).

even though firms operate in the same market pursuing similar strategies,

they may have different property control (coordination) over their

firm-specific assets in different regions (Devinney, Midgley, and Venaik, 2000)

Moreover, the targeted markets may be similar in characteristics, but they

may be geographically distant in reality This means that the degree of

dispersion of firm activities or the number of countries needs to be

included in the framework

In this regard, Porter (1986) introduced a model analyzing the

coordi-nation and the linkage across business units and countries His analysis

comes down to configuration and coordination of activities, which is

called “the configuration-coordination (C-C) model” (see Figure 1.6)

Configuration refers to the number of locations in which value chain

activities are operated and managed They can be geographically dispersed

or concentrated Coordination is how similar activities of the value chain

across national borders are controlled and synergized by the firm

However, Porter’s (1986) C-C Model is not free from criticisms

Country-centered strategy is a totally localized strategy while, export-based

strategy is pursued when products are made in one country and exported

to foreign markets with low coordination However, these strategies do

not show whether the number of foreign markets are many or a few

Figure 1.6 Porter’s (1986) C-C Model

Global strategy is pursued when products are made in one country and

sold in foreign countries with high level of coordination and

standardiza-tion Foreign investment strategy shows that the production may be

geo-graphically dispersed but it is highly coordinated

The main problem of this model is not distinguishing between the

upstream (production) and downstream (marketing) activities Thus, Moon

(2010) provided an extended model (see Figure 1.7) This model comprises

the number of countries to figure out and to what extent the activities are

concentrated or dispersed, and the level of coordination of the activities by

dividing the upstream and downstream activities of the firm He explained

that, by and large, production-seeking coordination and marketing-seeking

coordination are the two ends that firms seek for international strategies

For example, Toyota is more globalized in marketing, while GM is

more globalized in production These two firms are both regarded to be

global firms but are globalized in different aspects Thus, a distinction

between production and marketing shows a more concrete picture of the

firms’ different global strategies

Geographical dispersion is not always positive and it is accompanied by

costs and risks At the initial stage of globalization, firms invest in locations

that are geographically closer This is because geographically contiguous

Figure 1.7 Production-seeking and Marketing-seeking Model

Sources : Moon (1994; 2010).

countries are simply perceived to have similar cultures, political and

eco-nomic systems, and ecoeco-nomic development levels (Sethi et al., 2003), which

are foundations for overcoming a psychic distance Yet, it is a very simplistic

approach because geographical distances do not always equate with psychic

distances Then, let us take a look at a new map of cultural differences

1.5 Psychic Distances and New Geography

Psychic distance or unfamiliarity coming from different cultures, laws,

norms, values, political systems, business practices, and economic levels,

shapes global business strategies and determines firms’ location choices

Psychic distance becomes the key barrier to firms’ globalization and it

affects direction, performance, and entry mode of the international firms

(Brewer, 2007), because it is perceived as costs associated with foreignness

Psychic distance can be viewed from two perspectives: Macro and micro

In the macro perspective, psychic distance comes from history, politics,

economy, as well as educational and religious factors In the micro

per-spective, the way of doing business or the organizational structure is the

foundation for dealing with psychic distance It is difficult to draw a clear

line between the macro and micro perspectives, as they are intertwined

with each other and can affect firm performances in various ways

This can be seen from the Japanese firms’ experience in China Japanese

were among the first to open factories in China, but they have found

dif-ficulty in their business operations due to increasing costs (labor and

administrative costs to deal with labor disputes and stoppage at suppliers)

from incompatibility between Japanese and Chinese despite their

geogra-phical proximity Whereas in the macro aspect, anti-Japanese rioting over

historical grievances has caused great trouble for Japanese businesses, the

micro aspect played critical difficulties in operations in China For

exam-ple, Japanese way of management such as Just-In-Time (JIT) production

that made the Japanese firms amazingly efficient elsewhere left them

vulnerable to disruptions in China

Particularly, the modern Chinese workers, who presume a manager is

empowered to make decisions quickly, have not come to comply with

Japanese managers who have little autonomy and wait for orders from Tokyo

as they operate on consensus-based decision making Japanese managers,

who have dealt only with loyal, docile, and sacrificing employees at home,

have also struggled in training Chinese workers despite their geographical

proximity (Economist, 2010) They share different norms and values,

reli-gions as well as development paths that make them culturally more distant

in doing business than countries that may be physically more apart

Psychic distances, despite their important roles in international

busi-ness, were assessed from the Western perspective In the beginning, psychic

distances came from geographical distances The farther the countries are

from the Western countries, the less developed and different the countries

become Distant countries were perceived to be ethnically different, which

causes trouble and increased costs for the Western investors (Benito and

Gripsrud, 1992) This is why sometimes cultural differences were

trans-lated from a chauvinist perspective This aspect is mentioned in Perlmutter

(1969) on cultural differences in international business operations

1.5.1 Perlmutter’s Cultural Aspects

An early systematic work on firm motivation for internationalization,

based on cultural factors, was done by Perlmutter (1969) He explained

that firm strategy can be described in three ways: Ethnocentric

(home-country oriented), polycentric (host-(home-country oriented), and geocentric

(world-oriented) (see Table 1.1)

Ethnocentric managers (ethnocentricism) believe that the home

coun-try’s way of doing business is superior and thus should be applied to

for-eign operations The perception of doing business in forfor-eign countries is

based on “This works at home, therefore it must work in your country”

(Perlmutter, 1969) A unilateral counsel or directive flows from

headquar-ters to the subsidiary in a steady stream, and the main functions and

work-force are concentrated in headquarters, whereas foreigners are like the

“second-class citizens.”

Polycentricism on the other hand assumes a foreign country is different

and therefore is difficult to understand from the headquarters’ perspective

Local managers know the best local way of doing business, thus they should

have autonomy from the headquarters Executives from the headquarters

are apt to say “Let Romans do it their way […] as long as they earn profit,

we remain as the background” (Perlmutter, 1969) Polycentricism is about

Table 1.1 Three Types of Cultural Perspectives between the Headquarters and Subsidiaries

in subsidiaries

Varied and independent

Increasingly complex and interdependent Authority and

decision

making

High in headquarters

Relatively low in headquarters

Aim for a collaborative approach between headquarters and subsidiaries Evaluation and

control

Home standards applied for persons and performances

Determined locally Find standards which

are universal and local

Rewards and

punishments

High in ters, low in subsidiaries

headquar-Wide variation:

They can be high

or low rewards for subsidiaries

International and local executives rewarded for reaching local and worldwide objectives Communication

(information

flow)

High volume to subsidiaries ( orders, com- mands, advice)

Little to and from headquarters

Little between subsidiaries

Both ways and between subsidiaries Heads of subsidiaries part of management team Identification Nationality of

owner

Nationality of host country

Truly international company but identifying with national interest Perpetuation

Develop people of local nationality for key positions

in their own country

Develop best men where in the world for key positions everywhere in the world

every-Source : Perlmutter (1969).

accepting differences but at the same time acknowledging a big barrier in

communication and transferring information between the two different

cultures of the headquarters and the host country

Ethnocentric and polycentric executives see that cultural differences

prevail from cultural superiority or inferiority, so it is important to build

the third aspect — geocentrism Regardless of nationality, the concept of

geocentrism involves a collaborative effort between foreign subsidiaries and

home headquarters to establish universal standards and permissible local

variables for key strategic decisions (Perlmutter, 1969) Geocentrism is not

about superiority of the cultures, but about minimizing cultural costs and

creating the maximum value by compromising the best practices of the host

and home country cultures (Perlmutter, 1969) This is reflected in the

Unilever’s board chairman’s statement of objectives in India, “We want to

Unileverize our Indians and Indianize our Univerans.”

In comparing the types of international firms, ethnocentrism is similar

to “global strategy” of the firm which coordinates and standardizes the

strat-egies of the headquarters to its foreign subsidiaries; polycentrism is similar

to “multi-domestic strategy” which localizes products and business

pro-cesses to each region; and geocentrism is similar to “transnational strategy”

which is perceived to be “idealistic” and inherently unattainable

Although the role of culture in firm investments and operations is

important and unquestionable, isolating it as an independent variable is

challenging (Porter, 2000a) It is complex, intangible, and subtle, so it

is difficult to scale (Boyacigiller et al., 1996) It is also important to note

that cultural distances do not come from the differences in ethnicity or

geogra phical distances Cultures can be different within a region or similar

across different regions Hofstede (1980; 1983) was one of the most

renowned scholars to distinguish economic and cultural factors that

explain psychic distances

1.5.2 Hofstede’s Cultural Dimensions6

Hofstede (1980; 1983) tried to find typical patterns of cultural differences

and he first came down to four different dimensions: (1) individualism or

6

Information on Hofstede’s models is well documented in http://geerthofstede.com/

dimensions.html This part is largely based on the national realm of culture, yet,

Hofstede has also pointed out eight dimensions for organizational culture They are

(1) means oriented or goal oriented, (2) internally driven or externally driven, (3)

easygo-ing work discipline or strict work discipline, (4) local or professional, (5) open or closed

systems, (6) employee oriented or work oriented, (7) degree of acceptance of leadership

style, and (8) degree of identification with your organization

collectivism, (2) large or small power distance, (3) strong or weak

uncer-tainty avoidance, and (4) masculinity or femininity Individualism refers to

the social frameworks that take care of oneself and immediate family

members, while collectivism represents a society that looks after the

mem-bers in a group in a tightly-knit social framework A small power distance

means relatively equalized distribution of power among members in the

society and a high power distance accepts hierarchy or unequal

distribu-tion of power among members A society with high uncertainty avoidance

does not accept any unorthodox behaviors or ideas that can bring any risks

in the future, whereas low uncertainty avoidance represents the opposite

Masculinity represents a society that honors heroism, assertiveness, and

material rewards for success and competition Feminism stands for

mod-esty and care for the weak as well as for quality of life and cooperation

among society members

After a decade, Hofstede became fascinated by Confucianism in China

and added a fifth dimension which is short-term/long-term orientation in

his book (Hofstede, 1991) The fifth dimension was incorporated and

revised in the study conducted by Hofstede and his coworkers in 2010, and

was changed to the pragmatic or normative tendencies of people The

short-term orientated people seek the absolute truth and focus on

achiev-ing quick results Thus, they are more normative The long-term

orien-tated people seek virtuous life rather than searching for the truth They

believe that much of the truth depends on the situation, context, and time

They accept contradictions and show a strong propensity to save and

invest for the future, as well as perseverance for getting results (Hofstede,

Hofstede, and Minkov, 2010)

When the fifth dimension was revised, Hofstede and his coworkers also

added the sixth dimension that is indulgence versus restraint (Hofstede,

Hofstede, and Minkov, 2010) The indulgence refers to the human drives

related to enjoying life and having fun and the restraint refers to the society

that suppresses gratification of needs by means of strict social norms

1.5.3 Moon’s OUI Model

Hofstede’s six dimensions of cultural factors are independent variables and

they are all measured in relative scales He also introduced organizational

cultural factors apart from six national cultural dimensions Despite his

great contribution, his cultural factors are criticized for being not mutually

exclusive with each other To solve this problem and add missing variables,

Moon (2004a) introduced the Openness, Uncertainty Avoidance,

Indivi-dualism (OUI) model (see Table 1.2)

Among Hofstede’s cultural dimensions, Moon (2004a) explained that

there exist high correlations between the three; countries with large

“power distance” tend to have low “individualism” and high “long-term

orientation.” For example, individualistic society is responsible for one’s

conduct which gives rewards based on individual merit system rather

than hierarchical position (low power distance) and on tangible

short-term performance Collectivist society, on the other hand, is based more

on the social or inherited hierarchical status to maintain hierarchical

Table 1.2 The OUI Model and Its Cultural Variables

Openness Aggressiveness International changes

Global standards Willingness to accept new ideas Attractiveness Equal treatment

Professional job’s openness MNC’s activities (inward FDI) Uncertainty Avoidance Disciplinism Public order

Bureaucracy Bribery and corruption Frontierism Innovation and creativity

Entrepreneur’s core competencies Ability to seize opportunities Individualism Responsibility Job description and individual role

Corporate governance The relationship between labor and management

Reward Reward system

Firms’ decision process Professional compensation

Source : Moon (2004a).

order (high power distance) which emphasizes long-term stability rather

than short-term achievement

Descriptions under the “masculinity/femininity” dimension are also

highly overlapping with the ones under “individualism/collectivism.” For

example, masculinity that comprises aspects of competition and

feminin-ity of cooperation tend to overlap with a tendency to seek individual or

collective gains Thus, Moon (2004a) reorganized three dimensions of

Hofstede’s model (low power distance, individualism, and masculinity

versus high power distance, collectivism, and femininity) into one variable

of “Individualism” and sub-categorized it to “Reward” and “Responsibility.”

On the other hand, Hofstede’s “Uncertainty Avoidance” variable was

extended to include “Disciplinism” and “Frontierism.” Disciplinism is a

tendency to maintain order and, therefore, tends to have a low degree of

corruption and a high degree of restraint (i.e., low degree of indulgence)

Frontierism, on the other hand, is concerned with challenging and

explor-ing undeveloped fields which have close relationships with innovativeness

and creativity Although Moon’s OUI model was introduced prior to the

introduction of Hofstede’s sixth dimension, Moon’s extended “Uncertainty

Avoidance” factor covers the aspect of the sixth dimension as well

Restriction goes under Disci plinism, and Indulgence goes under Frontierism

Moon (2004a), with an understanding on cultures of small countries or

fast growing Asian countries, introduced a new variable, “Openness.” These

countries with lack of natural resources could achieve their economic

development through creating new competitive advantages, because they

were very open to internationalization Singapore and South Korea are

good examples (see Chapter 2) The Openness variable is subdivided into

Aggressiveness and Attractiveness A quick adaptation to international

changes and global standards as well as accepting new ideas is “aggressive”

way of being open, and accepting professional jobs and investments as well

as giving equal treatments towards foreigners and foreignness is regarded

as an “attractive” way of being open

As cultural factors or psychic distances are important for international

business, scholars have applied these factors to innovation, in

organiza-tional transaction, technology transfer, the sequence of foreign investments,

and entry modes (Shenkar, 2001) Yet, the correlation with cultural factors

shows different results among studies: Positive, negative or no relations

This can be explained by a lack of consensus in defining cultural and psychic

distances as well as methodologies and data sets (Shenkar, 2001)

Moon (2004a), on the other hand, said that OUI factors are closely

related to the competitiveness of nations, measured by the composite

index of the IPS model (see Chapter 7) The higher openness, uncertainty

avoidance, and individualism a nation has, the more competitive the

nation becomes Thus, when managing cultural factors, it is not only

cru-cial to improve OUI factors within the national boundary, but also to

make them competitive for doing business across countries

Countries with different degrees in OUI variables will cause conflicts

despite their geographical proximity Yet, finding complementary cultural

aspects among countries can pave a way for further growth For example, the

East Asian bloc shows different strengths in different pillars of the OUI

model (see Figure 1.8) Japanese show strengths in Individualism, Chinese in

Openness, and Koreans in Uncertainty Avoidance (Moon, 2004a) Although

Figure 1.8 Cultural Competitiveness and Distances between Japan, Korea, and China

Source: Moon (2004a).

Japanese have the highest indexes in all three OUI pillars compared to those

of Korea and China, the comparative strengths in these countries show a

potential for frictions Yet, when managed well, these cultural differences can

give new insights and business opportunities for cooperation Cultural

diversity thus has become one of the factors contributing to organizational

creativity and innovation as well as a source of competitive advantage rather

than causing friction.7

Psychic distances along with the geographical distances have initially

been analyzed in terms of the cost analysis The farther the countries are

geographically, the more the countries become distant in terms of cultures,

incurring high administration and hidden costs Just as physical distances

have been reduced by the development of transportation and

communica-tion technologies, psychic distances can also be overcome In the end,

reducing psychic distances is not only a matter of cost reduction, but also

a matter of learning and creating new business opportunities Increased

level of knowledge on a foreign country reduces both the cost and

uncer-tainty in foreign markets (Buckley and Casson, 1981; Benito and Gripsrud,

1992) At the same time, more knowledge on host countries accumulates

to the diversity of knowledge stock that becomes a source of competitive

advantage (see Chapter 2)

1.6 Conclusion

Globalization has become an inevitable trend, but few existing studies

have shown a good understanding of globalization This chapter illustrates

what globalization is and how it has changed the business landscape of

firm competition Firms do not just compete competing domestically;

they source foreign production inputs and sell their products in foreign

markets to survive and prosper in global competition Firms pursue

different international strategies that may change over time

Although physical and psychic distances were conventionally

consid-ered as costs and barriers in business operations, with technological

7

Advocates on “value in cultural diversity” insist that exposure to different cultures stimulates

new perspectives and creativity Understanding various cultures also helps firms be flexible

in different business operations and enhance problem solving skills (Cox and Blake, 1991)

advancement and an increased level of knowledge of foreign locations,

they have become the source of accumulating diverse knowledge stocks

and new business opportunities Firms can gain new knowledge stock

which will help firms upgrade and innovate while they can also expand the

overseas markets to increase their performance

According to the conventional Western FDI theories, firms go abroad

to exploit their own firm-specific advantages (see Chapter 3) In the

increasingly globalized business environment of today, not just Western

firms, but also developing country firms actively go abroad However, their

motivations are often quite different from the conventional Western

per-spective These new global firms go abroad to get access to strategic assets

such as technology and brand name rather than just to exploit their

exist-ing advantages (see Chapter 4) It is time to expand the scope of analysis

from a Western to a global perspective

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Chapter 2

International Business Strategy:

From Trade to FDI

Summary

We have looked at the changing nature of firms and business landscapes

due to physical and psychic distances Whereas physical and psychic

dis-tances were a matter of operational costs of doing business abroad, they

have evolved to become the source of new business opportunities As an

extension of “cost reduction” perspective to “learning” perspective, we delve

into theoretical foundations for international transactions, starting from

the distinction between the conventional means of trade and the new

means of Foreign Direct Investment (FDI) This chapter introduces then

how we can understand the competitiveness of a nation and a firm by

incorporating the concept of internationalization The evolution of

theo-retical foundation from economic to business perspectives gives a more

rigorous and comprehensive understanding of FDI and firm operations in

changing business environment

2.1 Two Means of International Transactions

2.1.1 Trade1

In the past, firms were mainly engaged in international transactions through

arm’s length exporting and importing This means that products were

pro-duced domestically and sold outside the national boundary In later stages,

firms started engaging in international production What was the reason for

firms to move outside of the national boundary?

1

This part was abstracted and extended from Cho and Moon (2013a).

Trade theories were developed based on the perfect market system The

mercantilist economic perspective of zero-sum game, where one’s gain

comes from the other’s loss, does not take into account of the value creation

of firms This perspective assumes that in order for a country to prosper, it

needs to export more than import, which encourages domestic production

This is how trade balance has become the representative measure of

national wealth that needs to be regulated and advocated under the

economic nationalism

After mercantilist’s view on world trade was Adam Smith’s absolute

advantage model based on natural law and invisible hand Smith saw

international trade is indeed not a zero-sum but a positive-sum game The

market participants, as long as they specialize in what they are good at, can

maximize the overall pie of the wealth of trading partners However,

according to this theory, only the strong ones, which have absolute

advan-tages, can survive and the weak ones cannot gain from international trade

Despite the great contribution by Smith to increasing efficiency through

specialization, absolute advantage theory could not fully provide a

persua-sive explanation of why countries are still enga ged in international trade

as many countries do not have any absolute advantages

This was later solved by David Ricardo who posited that nations

without an absolute advantage can also benefit through trade when they

specialize in the sectors which have “comparative” advantages, or less

dis-advantages This is because nations have to think about the opportunity

cost when calculating the growth of national wealth It is not only about

how much one produces but also about how much it does not lose The

country will specialize in the industry with less inferiority, so it can

mini-mize the disadvantage and complement it through international trade

The relative sense of advantages was calculated in terms of labor

produc-tivity Then why does the labor productivity differ across industries and

nations? Why do some countries have different disadvantages or

advan-tages in resources?

To explain the differences in comparative advantage of nations, Eli

Heckscher and Bertil Ohlin at the Stockholm School of Economics built on

the Ricardian model and explained that it is because the factor

endow-ments vary across nations Factor endowment perspective regards that

nations differ based on the factor inputs a nation possesses and goods differ

based on which factors are used for production of those goods Thus, the

intensity of the resources endowed in the production will be determined

by the comparative advantage of factor endowments a nation has

Heckscher–Ohlin model became the basis of factor price equalization that

was initially presented by Wolfgang Stolper and Paul Samuelson The factor

price equalization theory posits that the price of factor inputs will be

equalized in the end through free international trade

All these trade theories have been very influential and useful, yet the

assumption is that countries have to stick to their current state of

advan-tages they have at home There are two reasons for this First, trade theories

assume that factor mobility is possible only within the national boundary

but not across the boundary This is why Ricardian model is about

com-parative advantage between the two industries within a nation, rather than

between nations Second, because countries specialize in what they are

(comparatively) good at, they continue focusing on what they do, which

gives them no incentive for additional industry upgrade or change Thus,

trade theories cannot explain why some countries show structural changes

in export industries and why some countries outperform others over time

Let us take an example of Korea’s economic development Korea has

achieved 300 times of economic growth (GDP per capita) from 1960 (less

than 100 US dollars of per capita GDP) to 2014 (approximately 30,000 US

dollars), within half a century Its economic growth can be explained by

trade theories: high productivity and high export volumes What cannot be

explained yet is Korea’s upgrade of industrial structures that took place in

almost every decade

After the Korean War ended in 1953, the Korean economy was

devas-tated The country had only primary industries such as agriculture which

were not enough in quantity to support the whole nation, nor good in

quality to serve (foreign) markets Yet, under the president Park

Chung-Hee’s economic planning, Korea started developing light industries and

exported wigs and textiles From the 1970s, Korean firms started exporting

radios and black and white TV sets that were produced domestically as

original equipment manufacturer (OEM) of US and Japanese MNCs The

export boom gradually paved a way to heavy industries where the

govern-ment found the importance of basic materials such as iron and steel as the

backbone of a modern industrial economy